Market Bulletin - Keeping its powder dry
Bank of England’s rate hold decision reflects mixed market messages at home and abroad.
Last week, members of the Monetary Policy Committee (MPC) found themselves once again to be largely of one mind on the question of interest rates, as members voted 8–1 for no change to the Bank of England rate of 0.5%. The pound rose slightly after the decision, before newspapers turned their attention to the Labour leadership contest, and the landslide election of Jeremy Corbyn this weekend.
The two main tracks of Britain’s divided economy appear to be veering ever further apart. On Thursday the British Chambers of Commerce upgraded its 2015 growth forecast from 2.3% to 2.6%, emphasising the strong momentum of UK services (as well as consumer spending) but expressed fears of a deceleration in the third quarter. If services outperformed, manufacturing under-delivered, with output down 0.8% between June and July, and down 0.5% against the previous year, according to the Office for National Statistics.
Exports of manufactured goods dropped £2.3 billion to £22.8 billion in July, the worst results since September 2010. Domestically, supermarkets were a sore spot, as both Morrisons and Waitrose announced reduced revenues in the first half of the year. Asda, despite regaining the second spot among UK supermarkets, experienced the worst sales records in its history, dropping 4.7% in the second quarter. Sainsbury’s saw second-quarter growth of 0.1%. JP Morgan announced that it has cut current-year profit forecasts for Tesco, Sainsbury’s and Morrisons. Meanwhile, weak UK construction data hit housebuilders’ stocks, but the FTSE 100 Index ended the week up 1.45%, aided by modest gains from the mining sector.
The coming interest rate rise need not be feared. Adrian Frost of Artemis reflected that “the day rates go up is the day economies become more normal and free from the mysteries of quantitative easing. It is inevitable that markets will not like such a move. But for long-term investors, it is to be welcomed.”
Meanwhile, the government is receiving sustained attacks over its plans for the introduction of a UK-wide Living Wage. According to projections from the Office for Budget Responsibility, the reforms would mean the Living Wage (which applies to those above the age of 25) reaching £9.35 an hour by 2020. Wetherspoons and Manpower have complained publicly at the scale of the proposed change.
Among the more sanguine respondents was Lord Wolfson, CEO of Next, who announced the company’s results last week. Pre-tax profits rose to £347 million for the first six months of the year, up from £324 million, while sales rose to £1.89 billion, up from £1.84 billion. Lord Wolfson expressed confidence in Next’s ability to weather the change.
Nick Purves of RWC Partners also remains optimistic about the company’s prospects: “Next as a company appears to be able to strike the balance between looking after their employees and rewarding their shareholders; since October 2012 their staff are, on average, earning 43% more – but, over the same period, the share price has increased from £36 to £78. We remain supportive shareholders.”
The minutes of the MPC meeting made clear that its greatest concern was the impact of the slowdown in China on the world economy. Trade data from China last week showed the value of imports dropping 14.3% in August year-on-year, an even sharper decline than the 8.6% drop suffered in July. Exports were down 6.1%. Moreover, the country missed its August annualised targets for both fixed-asset investments – primarily property – and factory output.
If the Bank of England has its fair share of doves, the Chinese government has a full flight of them, devaluing the currency in August and deploying $236 billion in the past three months to prop up the plunging Shanghai stock market. The collective noun may be especially apt in this case, given investor concerns that official support measures are artificial and mark a government failure to face up to the reality of overpricing.
Stocks in East Asia enjoyed a surge late last week, however, and the Nikkei rose 7.7% on Wednesday, its greatest one-day rise since October 2008, although it remains afflicted by a bout of exceptionally high volatility and dropped 1.6% on Monday this week. There were marked increases in stock indices in Australia, South Korea and Hong Kong too, thanks in part to the stimuli expected in both China and Japan. Chinese stocks reached a three-week high, as reports revealed that international investors had moved at least £2 billion back into shares listed in Shanghai and Shenzhen since 21 August.
Trouble in China’s real economy lies behind much of the volatility currently dominating headlines, and here the figures may become still harder to trust in the coming months, following a ruling by the Chinese Communist Party that the emphasis in September will be on “strengthening economic propaganda”. Yet China is far from being the only reason volatility has spiked so dramatically. George Luckraft of AXA Framlington believes that “volatility is actually being compounded by bank regulation at the moment. Before the financial crisis, investment banks could act as market makers and take more risk in the market, which helped to reduce market volatility. It’s a very different environment now.”
Fed up waiting
While the Fed is not behind the initial surge in volatility, uncertainty over its rate behaviour is one reason volatility is refusing to ease. America’s central bank faces mixed indicators, however, when it comes to vote on rates on Thursday this week.
Second-quarter growth was 3.7% year on year and the August unemployment rate was down to 5.1%, while last week the S&P 500 rose by just over 2%, its biggest weekly gain for two months. But wage growth has largely stalled, with only limited recent indications of an improvement. Moreover, import prices dropped 1.8% in August, pointing to low inflation. A rise in interest rates could also increase corporate defaults, given the levels of cheap borrowing US companies have enjoyed for an extended period. Leverage is at its highest point since 2008 and both Moody’s and Standard & Poor’s have issued warnings about corporate defaults.
Emerging markets, many of them still struggling under the pressure of falling commodity prices, are watching the Fed’s moves very closely. Last week the World Bank warned that the Fed risked sparking “panic and turmoil” in emerging markets if it raised rates, because developing market growth remained unstable. However, in the same week, central bankers in Indonesia, Peru and Mexico spoke out in favour of a Fed rate rise, on the basis that it would help to reduce uncertainty.
Europe’s central bank finds itself in a very different position to the Federal Reserve, with quantitative easing still part of the lexicon and the latest eurozone inflation figure coming in at an insubstantial 0.2%, far beneath the target of close to 2%. Despite some large day-to-day swings, the FTSEurofirst 300 enjoyed its biggest weekly gain since July; but, significantly, the eurozone is still managing to keep itself off the front pages. The most immediate concern for Mario Draghi is, of course, the Fed rate decision later this week.
Fed Chairman Janet Yellen described a 2015 rate rise as “appropriate” but has not specified a timeline in greater detail. The bond market is pricing in the chances of a rate tightening at around 30%. A rate rise may not come in September, but few expect the doves to remain airborne for long.
Artemis, AXA Framlington and RWC Partners are fund managers for St. James’s Place.
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